PBoC should stop the silliness and float the RMB

This is morning we got this news (from Bloomberg):

China’s central bank conducted the biggest reverse-repurchase operations since September, adding funds to the financial system after money-market rates surged and equities slumped.

The People’s Bank of China offered 130 billion yuan ($19.9 billion) of seven-day reverse repos on Tuesday at an interest rate of 2.25 percent. The monetary authority suspended the operations in the last auction window on Dec. 31, ending a six-month run of cash injections that helped drive borrowing costs lower in an economy estimated to grow at the slowest pace in more than two decades.

The People’s Bank of China (PBoC) continues to behave as if there is not Tinbergen constraint, but the PBoC soon has to realize it cannot continue to try to ease monetary conditions through liquidity injects into the money markets, lowering of reserve requirements and cutting interest rates, while at the same time trying to maintain an artificially strong Renminbi.

What the PBoC effectively is doing it trying to ease monetary policy with the one hand, while at the same time tightening monetary policy with the other hand by intervening in the currency market to prop up the Renminbi.

Instead it is about time that PBoC either let the Renminbi float completely freely (which effectively would cause a significant depreciation of RMB) or implement a large devaluation – for example 30% – so to avoid any speculation of further devaluations and then introduce a peg to a basket of currency as hinted in December.

The problem with the present policy is that everybody in the market realizes that this is what we will get eventually and that has caused an escalation of the currency outflow from China and this outflow is likely to continue until the PBoC bites the bullet and introduce a completely new monetary regime. This halfway house will not stand for long and if the PBoC keeps fighting it the central bank will just do even more harm to the Chinese economy and potentially also cause an major banking crisis.

PBoC is not alone in making this mistake and the Tyranny of the Status Que is strong within central banks around the world. Two good example are Kazakhstan and Azerbaijan. Both countries have in recent months given up the tighten link to the US Dollar and devalued their currencies significantly. This in my view has been the right decision as both of these oil exporting countries have been suffering significantly from the continued decline in oil prices.

But neither the Kazakhstani nor the Azerbaijani central banks (and governments) have introduce new rule based monetary policy regimes. So one can say they have left the Dollar peg, but forgot to finish the job. Therefore policy makers in both countries should now focus on what regime should replace the Dollar peg. I would recommend an Export Price Norm for both countries, where their currencies are pegged to a basket of the oil prices and the currencies of the countries’ main trading partners.

And China need to do the same thing – not introducing an Export Price Norm, but rather let the Renminbi float and then introduce an NGDP target or a nominal wage growth target and it need to do it very soon to avoid an escalation of the financial distress.

The PBoC has the power to end this crisis right now by floating the Renminbi, but the longer this decision is postponed the bigger the risk of something blowing up becomes.

PS notice that despite the sharp rise in tensions between Saudi Arabia and Iran oil prices are now lower than on at the close of trading last week. That to me is a pretty strong indication just how worried that markets are about China.


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Oil exporters do not devalue to boost exports, but to stabilize public finances

Yesterday Azerbaijan’s central bank gave up its pegged exchange rate regime and floated the Manat. The Manat plummeted immediately and was essentially halved in value in yesterday’s trading.

Azerbaijan is not the first oil exporter this year to have given up its fixed exchange rate policy. Kazakhstan did the same thing a couple of months ago and last week South Sudan was forced to devalue by 85%. Angola also earlier this year devalued and Russia has now also given up its attempt to manage the float of the rouble.

And Azerbaijan is likely not the last oil exporter to give up maintaining a pegged exchange rate. Given the continued drop in oil prices and the strengthening of the dollar oil exporters with pegged exchange rate (to the dollar) will continue to suffer from currency outflows.

I have said it before – devaluation is not about competitiveness 

Critics of floating exchange rates and of devaluation of the kind the Azerbaijan i central bank undertook yesterday often say that devaluation just will cause higher inflation and any effects on competitiveness will be short-lived and that “internal devaluation” therefore is preferable.

Furthermore, these critics argue that for a country like Azerbaijan a devaluation will not help as oil is priced in US dollars anyway and that the countries have little else than oil to export.

However, this in my view misses the point completely. Giving up a fixed exchange rate and floating the currency (or introducing an Export Price Norm) is not about exports and competitiveness. Rather it is about avoiding a collapse in domestic demand and more practically it is about stabilizing government revenues.

Hence, for a country like Azerbaijan the majority of government revenues come directly from oil exports – typically directly from a government owned oil company and/or through taxes on oil and gas companies.

This means that if oil prices collapse the government revenues will collapse as well. However, a crucial part of this story that is often missed is that the important thing is what happens not to the oil price in US dollar, but the oil price denominated in local currency as the government’s expenditures primarily are in local currency.

Hence, a government can keep it’s oil revenue completely stable if the government allows the currency to weaken as much as the drop in oil prices (in US dollars).

Therefore, the choice for the government and central bank in Azerbaijan was really not a question about boosting exports. No, it was a question about avoiding public sector insolvency. Of course the Azerbaijani government could also have introduced massive austerity measures to avoid a sovereign default.

However, with a pegged exchange rate regime massive fiscal austerity measures would likely be extremely recessionary – and remember here that under a fixed exchange rate the budget multiplier typically will be positive and maybe even larger than one.

Hence, under a fixed exchange rate regime fiscal policy is at least in the short-term “keynesian” as there is no monetary offset. Said in a more technical the so-called Sumner Critique do not hold in a fixed exchange rate regime.

In that sense we should think of the devaluation in Azerbaijan as a one-off improvement in oil revenues – as oil revenues increases exactly as much as the currency was weakened yesterday.

The alternative to a 50% devaluation was a 20% drop in GDP

Let me try to illustrate this with an example. Let us first assume a oil-elasticity of 1 for Azerbaijani government revenues – meaning a 1% increase in oil prices increases the nominal revenue by 1% as well.

Yesterday USD/AZN jumped from 105 to 155 – so nearly 50%. This of course means that the oil prices denominated in Manat overnight also increases by around 50%.

Given government revenues presently are around 27% of GDP this means that a 50% devaluation “automatically” increases government revenues to around 40% of GDP (27 + 50%).

Said in another way overnight the budget situation was “improved” by 13% of GDP. If the government alternatively should have found this revenue through tax hikes (or spending cuts) without a devaluation then that would have caused a deep recession in the Azerbaijani economy.

In fact if we assume a fiscal multiplier of 1.5 (which I don’t think is unreasonable for a fixed exchange rate economy) then such fiscal tightening could have caused real GDP to drop by as much as 20% relative to what otherwise (now!) would have been the case.

Obviously there is no free lunch here and over time inflation will be higher due to the devaluation and to the extent that is allowed to be translated into higher expenditure some of the impact of the devaluation will be eroded. The extreme example of this is Venezuela or Argentina.

However, there is one very important difference between the two scenarios – devaluation or fiscal austerity – and that is under a fiscal austerity scenario it would be not only real GDP that would drop, but nominal GDP would likely drop even more.

This will not happen in the devaluation scenario where monetary easing exactly means that nominal GDP is kept stable or increases. This means that the debt dynamics will be much more positive than under an “internal devaluation” (fiscal austerity) scenario.

What I am arguing here is not discretionary monetary policy changes, but I am trying to explain why so many oil exporters have chosen to float their currencies this year and to illustrate why this is not about exports and competitiveness, but rather about ensuring government revenue stability and therefore avoiding ad hoc fiscal adjustments that potentially could cause a massive economic contraction.

So once again – I am not advocating “continues devaluations”, but rather I am advocating automatic currency adjustments to reflect shocks to the oil price within a clearly defined rule-based framework and I therefore also continue to advocate that commodity exporters should not peg their exchange rates against the dollar, but rather either float their currencies and implement a nominal GDP target or implement an Export Price Norm, where the currency is pegged to a basket of currencies and the oil price so the currency “automatically” will adjust to shocks to the oil price. This would stabilize not only government revenues, but also stabilize nominal spending growth and over time also inflation.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: or





The ‘Dollar Bloc’ continues to fall apart – Azerbaijan floats the Manat

I have for sometime argued that the quasi-currency union ‘Dollar Bloc’ is not an Optimal Currency Area and that it therefore is doomed to fall apart.

The latest ‘member’ of the ‘Dollar Bloc’ left today. This is from Bloomberg:

Azerbaijan’s manat plunged to the weakest on record after the central bank relinquished control of its exchange rate, the latest crude producer to abandon a currency peg as oil prices slumped to the lowest in 11 years.

The third-biggest oil producer in the former Soviet Union moved to a free float on Monday to buttress the country’s foreign-exchange reserves and improve competitiveness amid “intensifying external economic shocks,” the central bank said in a statement. The manat, which has fallen in only one of the past 12 years, nosedived 32 percent to 1.5375 to the dollar as of 2:30 p.m. in the capital, Baku, according to data compiled by Bloomberg.

The Caspian Sea country joins a host of developing nations from Vietnam to Nigeria that have weakened their currencies this year after China devalued the yuan, commodities prices sank and the Federal Reserve prepared to raise interest rates. Azerbaijan burned through more than half of its central bank reserves to defend the manat after it was allowed to weaken about 25 percent in February as the aftershocks of the economic crisis in Russia rippled through former Kremlin satellites.

The list of de-peggers from the dollar grows longer by the day – Kazakhstan, Armenia, Angola and South Sudan (the list is longer…) have all devalued in recent months as have of course most importantly China.

It is the tribble-whammy of a stronger dollar (tighter US monetary conditions), lower oil prices and the Chinese de-coupling from the dollar, which is putting pressure on the oil exporting dollar peggers. Add to that many (most?) are struggling with serious structural problems and weak institutions.

This process will likely continue in the coming year and I find it harder and harder to believe that there will be any oil exporting countries that are pegged to the dollar in 12 months – at least not on the same strong level as today.

De-pegging from the dollar obviously is the right policy for commodity exporters given the structural slowdown in China, a strong dollar and the fact that most commodity exporters are out of sync with the US economy.

Therefore, commodity exporters should either float their currencies and implement some form of nominal GDP or nominal wage targeting or alternatively peg their currencies at a (much) weaker level against a basket of oil prices and other currencies reflecting these countries trading partners. This of course is what I have termed an Export Price Norm.

Unfortunately, most oil exporting countries seem completely unprepared for the collapse of the dollar bloc, but they could start reading here or drop me a mail (

Oil-exporters need to rethink their monetary policy regimes

The Colombian central bank should have a look at the Export Price Norm

Ukraine should adopt an ‘Export Price Norm’

The RBA just reminded us about the “Export Price Norm”

The “Export Price Norm” saved Australia from the Great Recession

Should small open economies peg the currency to export prices?

Angola should adopt an ‘Export-Price-Norm’ to escape the ‘China shock’

Commodity prices, currencies and monetary policy

Malaysia should peg the renggit to the price of rubber and natural gas

The Cedi Panic: When prayers don’t work you go for currency controls

A modest proposal for post-Chavez monetary reform in Venezuela

“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression

PEP, NGDPLT and (how to avoid) Russian monetary policy failure

Turning the Russian petro-monetary transmission mechanism upside-down



If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: or





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